Part IV: Problem solving: Answer the following questions showing all the steps conducted to find the final answer.Lolly bank issues a $5 million loan to a firm with A- credit rating. The modified duration on the loan is 8 years. At the time of issue, the credit spread between A- bond and U.S. Treasury bonds is 3%. The bank believes that the borrowers’ credit rating may fall during the period of the loan. To hedge this credit risk, the banks enters (sells) a $5 million credit spread forward contract. At the end of the of the forward period, the borrowers credit rating does indeed drop to BB. The credit spread between BB rated bonds and U.S. Treasury bonds is 7%.Calculate the amount that the bank should receive from the forward buyer.

Solution- Loan amount = $5 million Treasury bond =3% Credit spread forward contract=$5 million…

Answered: Lolly bank issues a $5 million loan to…

International Financial Management

14th Edition

ISBN:9780357130698

Author:Madura

Publisher:Madura

Chapter11: Managing Transaction Exposure

Section: Chapter Questions

Problem 37QA

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Part IV: Problem solving:

Answer the following questions showing all the steps conducted to find the final answer.

Lolly bank issues a $5 million loan to a firm with A- credit rating. The modified duration on the loan is 8 years. At the time of issue, the credit spread between A- bond and U.S. Treasury bonds is 3%. The bank believes that the borrowers’ credit rating may fall during the period of the loan. To hedge this credit risk, the banks enters (sells) a $5 million credit spread forward contract. At the end of the of the forward period, the borrowers credit rating does indeed drop to BB. The credit spread between BB rated bonds and U.S. Treasury bonds is 7%.

Calculate the amount that the bank should receive from the forward buyer.

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